Continuous-time markets, such as those provided by stock exchange systems, are focused on providing the best price to investors and may process, for example, a very small number of shares of a given stock for a typical trade. In a typical scenario, investors wanting to buy shares of a specific stock are instantly (or near-instantly) matched with sellers who want to sell shares of the same stock, where a trade is executed if the bid price for an order of the buyer and the ask price for an order of the seller meet or overlap.
Discrete-time markets, such as call auctions, execute the maximum number of shares given the available limit orders to buy and sell. A limit order is an order to buy or sell a stock at a specific price or better. For example, a buy limit order can only be executed at the limit price or at a lower price. A sell limit order can only be executed at the limit price or at a higher price. In either case, a limit order is not guaranteed to execute. Instead, it depends on the prices of the available stocks, or other securities, available for trade in the market.
Limit orders may be traded, for example, by retail investors which may include individual investors or retail brokers who trade on behalf of individual investors. Retail investors who make public limit orders on, for example, a public stock exchange, often experience issues with high frequency traders, e.g., other investors that use automated trading systems or software platforms to identify the retail investor's public limit orders, e.g., by using a public book listing publicly traded orders, to fill their own high frequency orders by offering one tenth of a cent or so “better” price. Such practice allows the high frequency traders to jump in front of, or otherwise trade before, the limit orders of the retail investors.
The issues with high frequency are typically compounded when a retail investor needs to fill a large order of many shares because high frequency trading platforms typically seek to identify large quantity trades. To combat this, retail investors may employ a strategy of splitting a large size order into smaller, numerous, and separately traded orders to avoid the aforementioned consequences of being detected by the high frequency trading platforms. Consequently, their smaller, publically displayed limit orders would represent only a small portion of the full position needing to be bought or sold. Such a strategy can backfire, however, because splitting a large size order into numerous smaller orders can create new issues with the timing of the smaller trades, such as, for example, the retail investor's own trades affecting the share price for his or her subsequent trades or the retail investor losing a preferred trading price based on other market activity that occurs while the smaller separate trades are awaiting to be traded. For these retail investors, achieving the best price, for example, on a few hundred shares of the first of the smaller orders, does not satisfy their need to fill a large number of shares at a satisfactory price. And, even if the smaller order strategy is employed, there remains an opportunity for a savvy high frequency trader to detect the numerous publicly identifiable smaller orders trades, e.g., by detecting numerous small orders of the same stock, and not necessarily, a large quantity trade, and, therefore, still place orders in front of the retail investor.
Other investors, called institutional investors, may make limit orders on behalf of their respective members, e.g., fund participants. Institutional investors may include banks, insurance companies, pensions, hedge funds, real estate investment trusts (REITs), investment advisors, endowments, mutual funds, or institutional brokers who trade on behalf of such entities. Institutional investors typically make large size trades on major exchanges that can greatly influence the prices of stocks and other securities.
Institutional investors may trade with each other on alternative trading systems (ATS) that are not designed to interact with retail investors. The ATS allow institutional investors to make confidential trades of large sizes. Because the trades are confidential, at least some types of ATSs have come to be known as “dark pools.”
In addition, the number of ATS platforms available for institutional investors to trade on has grown significantly over the past several years. For example, these ATS platforms are now available from a number of providers including, for example, Barclays ATS, Credit Suisse Securities (USA) LLC, Interactive Brokers LLC, J.P. Morgan ATS, and UBS ATS. This variety of options creates a liquidity issue, i.e., because there currently exists a large number of options of alternative trading systems, the overall liquidity, e.g., the degree to which an asset, stock, or security can be quickly bought or sold in the market, is reduced for all institutional investors because there is no centralized or otherwise commonly managed system to facilitate the various institutional investor orders. Moreover, the large size orders, which are typical of the orders placed by institutional investors, further compound the liquidity problem, because there may be no other single market participant, such as another institutional investor, willing to enter into the other side of a large trade on a particular ATS platform. Accordingly, in such situations, an institutional investor using a given ATS may experience an unfavorable trading price or may not be able to fill a given order in the first instance.